1. Page 1 of 2
Economic Commentary
QNB Economics
economics@qnb.com.qa
April 27, 2014
Calm in Emerging Markets but Underlying Vulnerabilities Remain
Capital flows to emerging markets (EMs)
recovered in February and March 2014 leading
to calmer financial markets. However, the
fundamental weaknesses in specific EM
economies have not been fully addressed,
leaving them exposed to further rounds of
capital outflows, weaker currencies and falling
asset prices. Some EMs are likely to fare better
than others, depending on their underlying
fundamentals and the policy measures they
have taken so far to address their imbalances.
EMs received large amounts of capital inflows
during the period of Quantitative Easing (QE)
following the 2008 global financial crisis. Near-
zero interest rates in advanced economies
drove capital towards higher-yielding EMs.
However, since the announcement in May
2013 by the US Federal Reserve (Fed) of the
gradual reduction of its asset-purchasing
program—the so-called QE tapering—EMs
suffered bouts of capital outflows as yields in
advanced economies rose, leading to weaker
EM currencies, rising yields and falling equity
prices (see our commentary from February,
Emerging Markets Continue to Suffer from QE
Tapering).
Capital outflows were most severe in May
2013 after the initial announcement of QE
tapering, but inflows also dropped back to very
low levels in late 2013 and January 2014 when
the start of QE tapering was actually
implemented. Since February 2014, portfolio
inflows to EMs have then recovered along with
exchange rates and asset prices, begging the
question, is the crisis over?
The short answer is no. The EMs that were
most adversely affected by the tightening of
global liquidity from QE tapering can be
characterized by four principal factors. First,
they had structural economic weaknesses,
such as relatively large current account
deficits. Second, they maintained relatively
low foreign currency reserves, which act as
buffers to absorb capital outflows. Third, they
were confronted with high foreign ownership
of debt, which has tended to result in higher
capital outflows (see our commentary from
March, Foreign Ownership of Debt is an
Important Indicator of Vulnerability to the
Emerging Market Crisis). Finally, a slow or
weak policy response, such as delays in raising
central bank interest rates, has exacerbated
vulnerabilities.
Portfolio Debt and Equity Flows to EMs
(USD bn)
Sources: The Institute of International Finance (IIF) Portfolio
Tracker and QNB Group analysis
The EMs that have experienced the most
severe exchange rate depreciation include
Argentina, Indonesia, South Africa, Turkey
and Ukraine. Based on the factors mentioned
above, these are the countries that probably
remain the most vulnerable to further capital
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20
40
60
80
Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
TrendLine
QEtapering
announced

2. Page 2 of 2
Economic Commentary
QNB Economics
economics@qnb.com.qa
April 27, 2014
flight. Each had a high current account deficit
in 2013 (3.3% of GDP in Indonesia, 5.8% in
South Africa, 7.9% in Turkey and 9.2% in
Ukraine), with the exception of Argentina
where foreign exchange restrictions kept the
current account deficit near balance. They also
had relatively low foreign exchange reserves
at end-2013 (all below 14% of GDP compared
to an average of 21% in the 16 vulnerable EMs
we analyzed), limiting their capacity to defend
their exchange rates against capital outflows.
Furthermore, foreign ownership of debt is high
(30.0% of total sovereign debt in Argentina,
55.5% in Indonesia, 35.8% in South Africa,
42.7% in Turkey and 46.4% in Ukraine).
Central banks in Argentina, Indonesia, Turkey
and Ukraine have responded. The Argentinian
central bank was forced to raise interest rates
dramatically (up 17 percentage points since
May 2013) as FX reserves evaporated, forcing
a devaluation of the Argentinian Peso in
January 2014. In Indonesia, the policy rate has
been increased by 150 basis points and
Turkey’s repo rate has been increased by 450
basis points. The central bank in South Africa
is pursuing an inflation-targeting mandate and
the official interest rate has only been
increased by 50 basis points so far. Ukraine’s
central bank increased its policy rate by 300
basis points on April 15 to support the
currency, which has weakened by over 30%
since the end of February as its political crisis
intensified.
On the other hand, some EMs have avoided the
worst of the crisis. Brazil has hiked rates 3.5%
since May 2013, helping to support the
currency despite a large current account deficit
(3.6% of GDP) and moderate FX reserves
(17.1% of GDP) at end-2013. In India, skillful
central bank policies helped limit the
weakness of the Indian Rupee through policies
to curb imports and encourage exports. Low
levels of foreign ownership of debt (only 6.3%
of sovereign debt is foreign-owned at end-
2013) also helped insulate the Indian Rupee.
Poland’s exchange rate has been surprisingly
resilient to the crisis, partly due to a relatively
small current account deficit (1.8% of GDP),
moderate international reserves (18.9% of
GDP) and a high share of debt held by
foreigners (49.5% of sovereign debt).
In summary, the fundamental vulnerabilities
amongst selected EMs remain. QE tapering is
expected to continue until late 2014 and is
likely to put further pressure on capital flows
to vulnerable EMs. Additional exchange rate
weakness, higher interest rates, weak growth
and financial market instability can therefore
be expected. Based on the metrics that we
have analyzed, the most vulnerable EMs
appear to be Argentina, Indonesia, South
Africa, Turkey and Ukraine. However, there is
a second tier of EMs that have so far avoided
the worst of the crisis but remain exposed,
including Brazil, India and Poland. Further EM
instability is likely in the months ahead.
Contacts
Joannes Mongardini
Head of Economics
Tel. (+974) 4453-4412
Rory Fyfe
Senior Economist
Tel. (+974) 4453-4643
Ehsan Khoman
Economist
Tel. (+974) 4453-4423
Hamda Al-Thani
Economist
Tel. (+974) 4453-4646
Ziad Daoud
Economist
Tel. (+974) 4453-4642
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